Investors in alt funds haven't fared well. The Standard and Poor's 500 stock fund has gained an average 19.57% the past three years, with dividends reinvested. Most alt funds have lagged.

USA Today, Aug. 13, 2014

The above quote from USA Today captures a common misconception, and a recurring theme in the media, about alternative investments, namely that these investments have failed anytime they underperform the stock market. Investors need to know that alternative investments in general,1 and alternative mutual funds in particular, are designed to achieve returns that are more consistent and less volatile than those of the stock market on a long-term basis across multiple market cycles.

When comparing the returns of a diversified basket of alternatives to those of stocks, it becomes evident that there is a "tortoise and the hare" quality to this comparison. The table below illustrates this quality as it compares the performance of stocks to alternatives across various bull and bear market cycles. During bull market periods, there have been very few investments that could keep up with the returns generated by stocks, and alternatives are no exception. Conversely, when stocks experienced bear market periods or periods of flat returns, alternatives significantly outperformed stocks.

While Stocks Have Led in Bull Markets, Alternatives Have Proven Their Value in Bear Markets - and in the Long Run

Source: StyleADVISOR. Performance shown is from January 1997 through June 2014.

Using the tortoise and hare analogy, alternatives are a bit like the tortoise, their slow and steady approach has generated consistent and less volatile returns than stocks. Stocks are more like the hare in that they can generate significant returns quickly, but also have experienced extended periods of down performance.

When you compare stocks to alternatives over multiple market cycles you find that slow and steady indeed wins the race, as the table below illustrates. Since 1997, alternatives have generated a higher compound annual return than stocks and have done so with about a third of the volatility. Furthermore, the maximum decline for alternatives was less than half that of stocks.

As individual investors consider alternatives for their portfolio, it is critical that they have realistic expectations about how alternatives are designed to perform. From a return standpoint, investors should expect that, over the long term, alternatives, as whole, will generate returns similar to those of equities. However, during bull market periods, they should expect equities to outperform alternatives, and in bear market periods, they should expect alternatives to outperform equities. From a risk standpoint, investors should expect alternatives to generate returns that are less volatile, and have a much less severe maximum decline than those of equities. Talk to your advisor to discuss how alternatives can help you pursue your financial goals.

Notes

1. Notable exceptions would be alternatives such as private equity and direct real estate. Such investments tend be illiquid and are not available to investors in a mutual fund format.

* Alternatives are represented by a portfolio composed of 1) a 20% allocation to alternative assets represented by equal allocations to the FTSE Nareit All Equity REIT Index, Dow Jones UBS Commodity Index and Alerian MLP Index, 2) a 20% allocation to absolute return strategies represented by the BarclayHedge Equity Market Neutral Index, 3) a 20% allocation to global investing and trading strategies represented by equal allocations to the BarclayHedge Global Macro Index, BarclayHedge Multi Strategy Index and the BarclayHedge Currency Traders Index, 4) a 20% allocation to alternative fixed income composed of equal allocations to the Credit Suisse Leveraged Loan Index, HFN Fixed Income Arbitrage Index and the BarclayHedge Fixed Income Arbitrage Index, and 5) a 20% allocation to alternative equity represented by the BarclayHedge Long/Short Index. The performance of individual alternative investments will differ from that of the indexes. Stocks are represented by the S&P 500 Index (including dividends).

Important information

Alternative products typically hold more non-traditional investments and employ more complex trading strategies, including hedging and leveraging through derivatives, short selling and opportunistic strategies that change with market conditions. Investors considering alternatives should be aware of their unique characteristics and additional risks from the strategies they use. Like all investments, performance will fluctuate. You can lose money.

Standard deviation measures a fund's range of total returns and identifies the spread of a fund's short-term fluctuations.

The FTSE NAREIT All Equity REITs Index is an unmanaged index considered representative of US REITs. The Dow Jones UBS Commodity Index is designed to be a liquid and diversified benchmark for the commodity futures market. It is a rolling index composed of futures contracts on 19 physical commodities traded on US exchanges. The Alerian MLP Index is a composite of the 50 most prominent energy master limited partnerships calculated by Standard & Poor's using a float-adjusted market capitalization methodology. The Barclay Hedge indexes are recalculated and updated as soon as the monthly returns for the underlying funds are recorded. Only funds that provide Barclay Hedge with net returns are included in the index calculation. The number of funds that are currently included in the calculations for the most recent months can be found at barlcayhedge.com. Please note that the calculation for the number of funds is time-stamped and that the number of funds will continue to increase until all funds categorized within the sector have reported monthly returns. Credit Suisse Leveraged Loan Index represents tradable, senior-secured, US-dollar-denominated, noninvestment-grade loans. The HFN Fixed Income Arbitrage Index includes funds that attempt to exploit pricing inefficiencies between credit sensitive instruments which may include government or corporate debt, structured securities and their related derivatives. The S&P 500® Index is an unmanaged index considered representative of the US stock market. An investment cannot be made directly in an index.

Past performance does not guarantee comparable future results.

NOT FDIC INSURED

MAY LOSE VALUE

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Disclaimer: The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. The opinions expressed are those of the author(s), are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.